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Manfred Zeller and Manohar Sharma

FOOD POLICY REPORT

INTERNATIONAL FOOD POLICY RESEARCH
INSTITUTEWASHINGTON, D.C.JUNE 1998

The International Food Policy Research Institute was established
in 1975 to identify and analyze alternative national and international
strategies and policies for meeting food needs of the developing world on a
sustainable basis, with particular emphasis on low-income countries and on the
poorer groups in those countries. While the research effort is geared to the
precise objective of contributing to the reduction of hunger and malnutrition,
the factors involved are many and wide-ranging, requiring analysis of underlying
processes and extending beyond a narrowly defined food sector. The
Institutes research program reflects worldwide collaboration with
governments and private and public institutions interested in increasing food
production and improving the equity of its distribution. Research results are
disseminated to policymakers, opinion formers, administrators, policy analysts,
researchers, and others concerned with national and international food and
agricultural policy.

IFPRI is a research center of the Consultative Group on
International Agricultural Research and receives support from the Arab Fund for
Economic and Social Development, Australia, Belgium, Brazil, Canada, CARE,
China, Colombia, Denmark, the European Commission, the Food and Agriculture
Organization of the United Nations, the Ford Foundation, France, the German
Agency for Technical Cooperation, the German Federal Ministry for Economic
Cooperation and Development, India, the Inter-American Development Bank, the
International Development Research Centre (Canada), the International Fund for
Agricultural Development, Ireland, Italy, Japan, the Land and Agriculture Policy
Centre (South Africa), Malawi, Mozambique, the Netherlands, Norway, the Overseas
Development Institute, the Philippines, the Rockefeller Foundation, South
Africa, Spain, Sweden, Switzerland, the United Kingdom, the United Nations
Development Programme, the United States, and the World Bank.

Preface

This report presents information on the credit constraints that
poor rural households face, derived from detailed rural household surveys
conducted by IFPRI and its collaborators in nine countries of Asia and Africa
(Bangladesh, Cameroon, China, Egypt, Ghana, Madagascar, Malawi, Nepal, and
Pakistan). It uses this information to make the case for appropriate public
intervention in strengthening rural financial markets and draws conclusions
about areas where public resources may best be spent. It describes how informal,
often indigenous institutional arrangements - from savings clubs and lending
networks to small retail shops and input dealers - have succeeded in tailoring
savings, credit, and insurance services to the poor. What enables informal
institutions to provide sustainable financial services that banks and
cooperatives in the formal sector institutions, with few exceptions, fail to
provide? What are their strengths and weaknesses? What lessons can formal sector
institutions draw from them? The report argues that the basic problem lies in
institutional arrangements, summarily transplanted from urban-based formal
banking systems, that have high transaction costs for lenders and borrowers
alike. For the lender, these costs are incurred in screening large numbers of
borrowers, monitoring and enforcing unsecured loan contracts, and managing tiny
savings deposits. For the borrower, these costs take the form of time and other
resources spent securing loans or making deposits, or inappropriate deposit or
loan terms. Finally, the report looks at examples of recent institutional
innovations that overcome some of these obstacles. It concludes that just as
there is a role for the public sector to develop or support science-based
technologies, concerted public action is also needed to create an enabling
environment in which institutional innovation is encouraged and given more room
to spread. Governments, donors, banking practitioners, nongovernmental
organizations, and research institutions must work together closely to pinpoint
the costs, benefits, and future potential of emerging rural financial
institutions.

The report presents empirical results and conclusions from a
multicountry research program at IFPRI, that began formally in 1994. Many IFPRI
staff and collaborators from other research and government institutions have
directly or indirectly contributed to the country case study research and
synthesis work. Rosanna Agble, Joachim von Braun, Sumiter Broca, Franz Heidhues,
Eileen Kennedy, Zhu Ling, Sohail Malik, Charles Mataya, Mohammed Mushtaq, Ellen
Payongayong, Alexander Phiri, Zillur Rahman, Gertrud Schrieder, Simtowe, Rosetta
Tetebo, Tshikala Tshibaka, and Jiang Zhong Yi all contributed. We also thank
Lawrence Haddad and Bonnie McClafferty for comments, and Phyllis Skillman for
editing this manuscript.

Financial support for the cross-country synthesis of results was
provided by the Ministry of Economic Cooperation and Development (BMZ), Federal
Republic of Germany and the German Agency for Technical Cooperation (GTZ). The
individual country studies were supported by the following donor agencies:
Bangladesh, Cameroon, China, and Madagascar (BMZ and GTZ), Egypt and Pakistan
(U.S. Agency for International Development [USAID]), Malawi (UNICEF, The
Rockefeller Foundation, GTZ, USAID, and since 1998, Irish Aid), Ghana (USAID),
and Nepal (USAID, Win-rock International, GTZ, and International Development
Research
Centre).

Introduction

The myth that poor households in developing countries, who often
earn less than a dollar a day, are not creditworthy or able to save has been
firmly put to rest in recent years. Poor households, it has been found, place
special value on reliable and continued access to different types of financial
services, available at reasonable cost and catering to their specific needs.
Credit and savings facilities can help poor rural households manage and often
augment their otherwise meager resources and acquire adequate food and other
basic necessities for their families. Credit facilities enable them to tap
financial resources beyond their own and take advantage of potentially
profitable investment opportunities. Well-managed savings facilities provide
incentives for households to build up funds for investment or future
consumption. Credit and savings facilities enable farmers to invest in land
improvements or agricultural technology such as high-yielding seeds and mineral
fertilizers that increase incomes (while sustaining the natural resource base).
For rural households who do not own land, credit and savings facilities can help
establish or expand family enterprises, potentially making the difference
between grinding poverty and an economically secure life. Short-term borrowing
or savings are often used to maintain consumption of basic necessities when
household incomes decline temporarily - after a bad harvest or between
agricultural seasons, for example.

The task of providing financial services at a reasonable cost to
those who have limited assets has not been easy, however. Until the 1980s in
many developing countries, state-run agricultural development banks took the
lead in establishing formal credit markets in rural areas. However, the
shortcomings of the banking principles that they were based on - collateralized
lending, an organizational setup without any incentives to do business with the
poor, excessive dependence on government funding, and pervasive political
patronage - severely handicapped their performance. The provision of savings
services was also largely neglected because the importance of providing deposit
services to the poor was not appreciated and because donor finance was available
on attractive terms. Distributing loans at subsidized interest rates was
emphasized. And it was all too easy for the socially powerful and the wealthy to
preempt most of the benefits of the subsidized distribution of credit. Moreover,
in some countries, political leaders found it to their advantage to resist any
moves to collect long-outstanding debts from subsidy recipients, and in many
cases leaders periodically announced loan amnesty or interest remission programs
in order to attain political objectives. These types of actions greatly eroded
borrower discipline and loan arrears ballooned. Not only did the banks fail to
serve the poor who were unable to pledge collateral, they also became
chronically dependent on larger and larger infusions of subsidy money, quickly
sliding beyond any prospect of long-term financial sustainability. Many of them,
in effect, degenerated to costly and inequitable income transfer programs.

In the past 15 years, support for state-sponsored agricultural
banks has greatly declined, and the need for financial market reforms to rectify
distortions caused by past government policies is now almost universally
acknowledged. However, governments, donors, and nongovernmental organizations
(NGOs) continue to look for alternative models for extending financial services
to the rural poor in an effective and economically sustainable way. Typical
questions asked are what types of financial services are demanded by the poor?
How does access to credit affect the welfare of the poor? How can rural
financial institutions more effectively reduce poverty? What kinds of
innovations in institutional design are called for and how can they be
generated? What is the role of government in this process? The solutions
proposed in answer to these questions are often confusing and conflicting,
frequently the result of taking extreme positions on some issues or generalizing
from a narrow context. This report attempts to provide a balanced discussion of
the underlying issues, giving due attention to competing claims and points of
view.

Client Profile

Successful provision of financial services to the poor requires
a clear picture of who the poor are. But generalizations are hard to
make. Conditions of the poor in Latin America or Central Asia are quite
different from those in South Asia or Africa. Hence, the nature of the
constraints and the best approach for tackling them depend on the
characteristics of the target population. Approaches that work in one region may
not be readily transplanted to another, and services that successfully address
the demand of one type of clientele - poor agricultural traders, for example -
may fail to address those of another type - semisubsistence farmers in the same
region. Inadequate understanding of the conditions of the client population or
the context within which policy decisions are made often leads to tension among
policy-makers, donors, and managers about what is the best way to support
financial services for the poor. With this in mind, some major characteristics
of the poor and their participation in formal and informal financial markets in
rural areas of Africa and Asia are identified here. The data for the analysis
are derived from nine household surveys conducted by IFPRI, that collected
detailed data on credit market participation.1 Here the focus of the
intercountry comparisons is not so much the nature of credit transactions
themselves (as conditions among countries vary greatly), but the differences
between the poor and the nonpoor within countries. The poor are
defined here as the bottom one-fourth of the sample households when ranked by
per capita household income levels.

The extremely limited resource base of the poor in Asia and
Africa is evident in Table 1. The majority of the poor lack basic education, are
primarily dependent on agriculture for their livelihood, own extremely small
amounts of land for cultivation, and support large families at low average per
capita income levels. Further, since rural areas are not as well serviced as
urban centers by physical and social infrastructure such as roads, schools,
telephones, radio, shops, and health clinics, their capacity to take advantage
of market opportunities is severely curtailed. Households belonging to the
lowest income quartile spend as much as 91 percent of their consumption budget
on food (Figure 1). Even so, because their earnings are so low, they sometimes
go hungry.2 As a result, the consequences of a drop in their earnings
or the need to finance unexpected expenditures such as medical expenses could be
quite serious. The cycle of borrowing during adverse times or during planting
seasons and saving or repaying loans after harvest or when earnings are good is
an integral part of the livelihood system of the poor. This is evident in IFPRI
studies in Pakistan, Madagascar, and Nepal. In Nepal, an overwhelming majority
of the poor, about 72 percent, engaged in some form of financial transactions.
In Madagascar, nearly half of the poor households reported that loans were used
to cope with household emergencies when they occurred. In Pakistan, a 1985 rural
credit survey conducted by the government of Pakistan indicated that nearly 40
percent of poor households engaged in credit transactions.3

a Household head refers to the major
family laborer. For years of education of household head, the category
none refers to the percentage that are illiterate; under five
years to those who had at most some primary education; five to eight
years to those who completed some junior level school; and nine or
above to those who completed some senior level school.

b Household heads working principally as daily
laborers in agriculture account for an additional 37.6 percent for the poor and
10.1 percent for the nonpoor.

Figure 1 - Percent of consumption
budget allocated to acquiring food

Source: IFPRI research on rural finance (see note
1).

The average cumulative yearly amount borrowed by poor households
from the formal and informal sectors ranges from about US$4 in Malawi to US$80
in Bangladesh to US$133 in Cameroon. The samples drawn are not nationally
representative; with the exception of China, Egypt, and Pakistan, they are
concentrated in areas and in villages where formal financial institutions are
placed. For this reason, reported levels of borrowing are likely to be higher
than national averages. Nevertheless, Figure 2 shows that the nonpoor households
(the upper three quartiles of household income) borrow much more than the poor,
with the exception of Ghana.4 Moreover, the loan amount shown in
Figure 2 is not available to the borrower throughout the year, but only for
several weeks or months. This is because most informal loans are given for only
a few days or weeks. Even many formal loans obtained by the sample households
are seasonal loans for agriculture or rural micro-enterprises. The smallest
amount borrowed is in Malawi, a very poor country with a relatively inactive
informal credit market.

Figure 2 - Average amount borrowed
from formal and informal rural financial sectors per household per year

Source: IFPRI research on rural finance (see note
1).

Informal lenders - friends, relatives, neighbors, informal
groups, or moneylenders - provide the bulk of the loans in every country except
Ghana and Malawi (Figure 3). In Pakistan and Cameroon, for example, less than 5
percent of the amount borrowed by poor rural households was obtained from formal
lenders. In this report, formal lenders consist of state and agricultural
development banks and new microfinance institutions. The latter group includes
credit unions and cooperatives, group-based programs run by government agencies
or nongovernmental organizations, and village banks. The new member-based
microfinance institutions successfully reach the poorest income quartile in
Bangladesh and Malawi.

The poor obtain a smaller share of their loans from the formal
sector than the non-poor in six countries (China, Egypt, Madagascar, Malawi,
Nepal, and Pakistan), about the same in one country (Cameroon), and a larger
share in two countries (Bangladesh and Ghana) (Figure 3). Even in a country like
Egypt that has a relatively dense coverage of formal financial institutions, the
role of informal lenders remains important. In Bangladesh, member-based credit
programs run by NGOs now play a significant role in providing credit to the
rural poor. In Ghana, the villages selected for the survey benefited from rural
banks and NGO-assisted credit programs, the latter targeting poor female-headed
households.

Figure 3 - Share of different
sources of loans to poor and nonpoor, by country

Figure 4 indicates how households spent their loan money. About
one-half to almost nine-tenths of the loans obtained from the formal and
informal sectors combined went to consumption-related purchases. In Pakistan,
more than 80 percent was spent on consumption, food and nonfood combined.
Moreover, in six out of eight countries, with Malawi and Nepal the exceptions,
loans for consumption are more important for the poorest quartile than for the
nonpoor. In every country, the share of loans used for consumption was higher
for informal loans than for formal loans.5 In Malawi, only a small
share of loans was used for consumption because the Malawi Rural Finance
Company, the major rural lender, provides all loans in kind in fertilizer and
seeds.

Figure 4 - Stated use of formal and
informal loans by the poor and nonpoor, by country

Why do more loans finance consumption activities than production
or investment activities? First, the main suppliers of credit, informal lenders,
are generally ill-equipped to finance substantial, long-term investments since
they rely on their personal funds. The average duration of informal loan periods
was, for example, 86 days in Bangladesh and 65 in Madagascar.6 The
characteristics of informal loans make them more useful for financing short-term
activities such as consumption stabilization and providing working capital for
off-farm enterprises. Formal loans, which are larger in amount and longer in
duration, are more useful for financing seasonal inputs and investments.

Second, in poor households the spheres of consumption,
production, and investment are not separable in the sense that consumption and
nutrition are important to a households ability to earn income. If a
laborer does not have enough to eat, he may be too weak to work productively. In
general, family labor is by far the most important production factor, and the
maintenance and enhancement of labor productivity is central for securing and
increasing income.

Once minimum requirements for a healthy and adequate diet have
been met, additional consumption does not generate further increases in labor
productivity. Many view such excess consumption as a luxury and see no social
benefit in financing it through publicly supported programs. Yet, it is fair to
say that luxurious or excessive consumption is extremely rare among the rural
poor. Thus, in considering policies for providing banking for the poor,
consumption loans spent mostly on foods needed to obtain a balanced diet or to
improve the health of family labor should be seen as productive loans because
the loan enhances the familys ability to earn.

Bankers in particular frequently argue against consumption loans
on the grounds that loans should finance activities that generate income for
repaying the loan. In actuality, however, the current practice of lending only
for narrowly defined productive activities seldom prevents rural households from
diverting borrowed funds from production to consumption needs, since lenders
rarely have the resources and time to supervise loan use.7 Only when
loans are given in kind - in seeds or fertilizer, for example, instead of cash -
do farmers have difficulty in diverting the loan to consumption uses. The data
show that the share of loans used for consumption borrowed from the formal
sector is lower than the consumption share of informal loans, but it still
ranges from 9 percent in Ghana to 54 percent in Nepal for all households. The
Nepal study indicates that borrowers often take advantage of the fungibility of
financial instruments to divert investment-tied loans to finance consumption
expenditures that, in the households own calculation, offer greater
returns. But just because a loan is used for consumption purposes does not imply
that repayment will falter. Consumption loans in Cameroon and Madagascar were
found to have the same or even higher repayment rates than production
loans.8

What about the adequacy of rural financial services? In spite of
the vibrant informal markets that can be observed in many countries, financial
services for the poor remain inadequate.9 In countries as diverse as
Bangladesh, Ghana, Madagascar, Malawi, and Pakistan, access to credit and
savings facilities is severely limited for small farmers, tenants, and
entrepreneurs, particularly women. A useful way of examining household access to
financial markets is to examine credit limits imposed on them by
lenders.10 In Bangladesh the median formal credit limit is $50 and
the informal limit is $13. The ability to borrow is significantly more
restricted in Malawi, where the median formal credit limit is zero and the
informal limit is US$3.

Such low credit limits mean that while some households
frequently are unable to borrow enough to meet their needs, other households
simply do not apply for a loan at all because of the expectation that they will
be denied. In Madagascar, for example, about 50 percent of loan applicants
received less than they asked for or nothing from formal and informal lenders
alike.11 In Ghana, Madagascar, and Pakistan, IFPRI studies show that
a significant proportion of the poor who do not apply for loans are discouraged
from applying by the strict collateral requirements and high transaction costs
frequently involved in doing business with formal institutions. There is some
variation in the percentage of discouraged nonborrowers by country; it is
highest in Ghana and lowest in Madagascar (Figure 5). Given such widespread
credit-rationing, it is entirely possible that even households with average
annual incomes above the poverty line may not be able to avoid transitory food
insecurity when faced with an adverse shock such as a bad harvest or serious
illness of a family member.

Figure 5 - Self-reported reason for
households not borrowing, by country

Source: IFPRI research on rural finance (see note
1).

While these figures describe the extent of inadequate access to
credit, one must not assume that all households who do not borrow lack access to
credit. In fact, Figure 5 shows that the share of voluntary nonborrowers ranges
from 11 percent in Ghana to nearly 59 percent in Madagascar. Among the most
important reasons cited for not borrowing were adequate liquidity within the
household, lack of profitable investment opportunities that could carry the cost
of the loan, and inability or unwillingness to carry the risks of indebtedness.

Three important implications may be drawn from the information
presented here about clients:

· A significant
number of poor households in developing countries experience real constraints in
the financial market in the sense that they are unable to borrow as much as they
would like at the prevailing transaction terms. Given that most of the poor
attempt to borrow in order to finance consumption of food and other basic goods
that enhance health and labor productivity, such constraints may force poor
households to eat less food or cheaper foods with lower nutritional value. Also,
when consumption levels are already precariously low, they may be forced to
cancel or postpone profitable investments or sell off assets - sometimes at a
substantial loss - to meet irreducible consumption needs. This may lead to
greater impoverishment in the long run.

· Because the cost of failure
can be very high at extremely low incomes, poor households are likely to be
particularly risk averse and sensitive about the kinds of projects that they
choose for financing. Access to credit and savings options may enhance their
capacity to bear risks and therefore indirectly foster technology adoption and
asset accumulation.

· Poor households in Africa and
Asia face complex, multiple constraints on earning opportunities. They often
lack education, markets, and other essential services. Hence, the impact of
financial services on welfare is likely to vary with accessibility to
complementary inputs such as irrigation, education, and market services. In some
environments or for some socioeconomic groups, access to micro-finance may do no
good, while in other regions or for other groups, it can make an important
difference.

Committing Public Resources to Rural Finance

Policymakers, advisers, and managers have not reached consensus
about how governments should intervene in and regulate the rural financial
sector. Some argue that a microfinance institution should be a purely financial
institution, functioning under the principle of full cost recovery. Performance
should be measured not just by the extent to which current costs are fully
recovered, but also by the cost recovery that would have taken place had all
types of subsidies been eliminated. Only then, they say, is there any prospect
for sustaining these services over the long run, when subsidized funds from
donors and governments have dried up. If the poor are unable to make profitable
use of financial services priced at full cost, then these services ought not be
used as instruments for poverty alleviation. This line of argument implies that
public resources could be better used in other poverty alleviation activities,
since well-run financial institutions should be able to service the poor and
maintain adequate financial returns. Banco Sol in Bolivia and the village banks
(Unit Desa) of the Bankya Rakyat Indonesia (BRI) are often cited as good
examples.

But this kind of advice clashes with real world experience where
most microfinance institutions that serve the poor, including well-known ones
such as the Bangladesh Rural Advancement Committee (BRAC) and the Grameen Bank
in Bangladesh, depend on subsidies from national governments and international
donors.12 The arguments for committing public resources to rural
financial institutions are made on two grounds: market failure and poverty
alleviation.

Market Failure and Institutional Innovations

In the past, the development and spread of financial
institutions were suppressed by excessive state interference, such as rigid
exchange rate regulations and caps on interest rates. Today, it is widely
recognized that the basic roles of government are to establish macroeconomic
stability; to ensure that financial markets are free to respond to economic
incentives, while following prudential banking practices; and to maintain and
enforce a legal framework that ensures contract compliance. However, while a
liberalized financial market is a necessary condition for improving the supply
of financial services to the poor, it is not sufficient in itself. Market
liberalization alone has not been able to trigger innovation in new financial
instruments that reduce transaction costs for the poor.13 This is
because rural financial markets of developing countries have inherent problems
that make investments risky and costly.14

· Clients are too
scattered geographically, making service delivery expensive.

· Since most of the clients
derive their incomes from agriculture, they all tend to want to borrow at the
same time, say in the preharvest season, and to save immediately after the
harvest. This makes it difficult for the financial institutions to diversify
their portfolios.

· Information about potential
borrowers is difficult to obtain, especially when they are scattered, making
loan applications costly to evaluate.

· The poor own few assets,
making it in-feasible for the financial institution to secure its lending with
collateral.

Typically the lender must spend time and resources on assessing
the creditworthiness of the loan applicant and seek alternative forms of
collateral. Given traditional techniques of lending, these costs often prove
excessive. As a result, commercial banks shy away from rural clients altogether,
limiting their services to the urban or periurban economy, where information on
prospective borrowers is less costly to obtain and transaction volumes are
larger. There is little evidence, as yet, that financial institutions in the
private sector are willing to invest resources to devise profitable savings and
loan services for the rural poor.15

Improvements in literacy, household incomes, communication
infrastructure, advances in banking technology and telecommunications, and
financial sector reform are likely to decrease transaction costs in the future.
While it may be best for private banks to wait until conditions for investment
are favorable, waiting may not be the optimal government policy. Institutional
innovations that reduce the cost of service delivery and improve its usefulness
for the poor are essential for enhancing the efficiency and long-run
sustainability of rural financial programs. This provides a strong reason for
directing public resources toward policies that generate institutional
innovations in the rural financial sector. There will be even more payoffs if
these innovations, which are in the nature of public goods, are eventually
adopted by private sector financial institutions to profitably provide services
to the poor.

Rural Financial Institutions and Poverty
Alleviation

The second argument for committing public resources to rural
financial institutions is that provision of financial services is a potent tool
for poverty alleviation, and public resources are called for to deliver these
services to the poor.16 Institutions such as the Grameen Bank or the
Malawi Mudzi Fund receive a significant amount of public resources. Their
clients are much poorer than the clients of Banco Sol or the BRI, and it is
likely that the poorest of them would be left out if they had to pay for
services at full market prices.

Managers of microfinance institutions in Asia and Africa often
find that providing financial services to the poor is not enough to attract the
poorest clients because of the many constraints they face. Credit may offer low
returns to investment for households that own tiny plots of unirrigated land of
low productivity, especially when they are illiterate, in ill health, or lacking
experience in high-yielding agrotechnology or nonfarm microenterprises. For
these reasons, institutions such as Freedom from Hunger in Ghana and BRAC and
the Grameen Bank in Bangladesh offer financial services in combination with
other complementary services, such as basic literacy programs, training in
enterprise management, and education in nutrition, health, and family planning
that are likely to increase the productivity of the loans provided.

What then is the case for allocating public resources to rural
financial institutions for poverty alleviation? Is there a case for combining
credit services with other kinds of services? Are these hybrid programs more
effective in reducing poverty than minimalist credit programs? The answers
depend on the potential impact of financial services on poverty and how they
compare with other means of reducing poverty. Clearly, if an additional dollar
spent on a credit-based program reduces poverty by a greater amount than a
dollar spent on another poverty reduction program, then there is a case for
redirecting resources to credit-based programs. Measuring the effects of these
programs on poverty alleviation is therefore an important step toward better
informed decisions. But making impact assessments is by no means
straightforward, since a host of other factors that affect poverty have to be
carefully controlled for. This is especially difficult in the case of hybrid
programs where disentangling program credit effects from noncredit effects can
itself be daunting. Nonetheless, recent years have witnessed a number of
research undertakings that have made progress toward measuring impact (Box 1).

Box 1

EVIDENCE ON IMPACT

Recent evidence indicates that loans from well-managed and
innovative rural financial institutions, far from being one-shot income
transfers, have helped poor families make permanent positive changes in the
quality of their lives.

· In
Bangladesh, BRAC has had significant positive effects on school enrollment,
asset holdings of households, and food consumption.18

· Also in Bangladesh, household
participation in credit markets has smoothed fluctuations in the weights of
preschool children. Growth patterns of children in landless households were
influenced by credit market imperfections.19

· A study of the effects of
borrowing constraints on the timing of human capital investments in Peru shows
that if parents are credit-constrained and a child could work for wages, parents
are likely to withdraw the child from school in order to smooth
consumption.20

· Credit access provided by both
the Grameen Bank and BRAC in Bangladesh had a positive impact on womens
empowerment and contraceptive use.22

· In Ghana, the combination of credit with education
services in womens groups resulted in higher off-farm income from
microenterprises, improved household food security, and improved nutritional
status of children.23

The results from IFPRIs own research program also point to
generally (but not uniform) positive effects of credit on income, technology
adoption, and food consumption (Table 2).17 Households with improved
access to credit are better able to adopt technology, increase their incomes,
and improve food expenditures and calorie intake than those who do not have
access to credit. However, the effects on nutritional status, an important
indicator of poverty, are not clear.

Table 2 - A summary of positive or negative effects of credit
access on welfare, by country

Indicator of welfare outcomes

Observed Impact of credit programs

Bangladesh

Cameroon

China

Madagascar

Malawi

Nepal

Pakistan

Household income level

+

+

+

+

?

n.a.

n.a.

Technology adoption

n.a.

n.a.

n.a.

+

?

n.a.

+

Total food expenditure

+

n.a.

+

n.a.

?

n.a.

+

Total calorie intakea

+

?

+

+

?

n.a.

n.a.

Nutritional status of childrenb

?

?

n.a.

?

?

n.a.

n.a.

Consumption variability

-

n.a.

n.a.

n.a.

n.a.

-

n.a.

Source: Econometric results are presented in
individual country reports and other publications listed in note 1.

Note: A plus or minus sign indicates positive or negative impact
statistically significant at the 10 percent level. A question mark means that
the effect was not statistically significant, n.a. indicates that an estimate
was not available.

a No significant effect on caloric intake was found,
but 75 percent of the households already met at least 80 percent of total
caloric requirements.

b Regressions were run separately for each major type
of credit program. One credit program showed positive effects on preschooler
height-for-age. The results for two other programs were not
significant.

Access to credit or participation in a formal credit program
positively affected household income in four of the five countries where such an
assessment was made. The study in Malawi, however, did not indicate such an
impact, possibly because the Malawi survey coincided with an exceptionally bad
harvest year due to inadequate rainfall. Studies in Madagascar and Pakistan,
which specifically examined the effects on input use, concluded that improved
access to credit increases the use of agricultural inputs, especially fertilizer
and improved seed. In three out of four countries, credit access had a positive
effect on total food expenditures (Bangladesh, China, and Pakistan). Credit was
also found to reduce consumption variability in Bangladesh and Nepal. The effect
on calorie intake, on the other hand, was not significant in two of the five. No
relationship between the nutritional status of children and access to a credit
program was found in any of the country studies, probably because good nutrition
is the product of a complex interaction between food intake and other factors
such as access to safe water and sanitation, access to health services, and
nutritional knowledge of caregivers.

Current evidence therefore indicates that, overall, the effects
of credit programs on welfare can be significant under many but not all
circumstances. What needs more evaluation in the future are the program costs
incurred and the resulting ratios of benefits to
costs.24

Informal Markets: What Lessons Can We Learn from Them?

In most developing countries, it is the private, informal
markets that the rural poor turn to for their financial needs. Why have these
institutions succeeded in providing services to the poor when formal
institutions have not? What are their basic limitations? The answers may
indicate important directions that public policy should take in encouraging
institutional innovations.25

Typically, informal institutions can be categorized as follows:

· Lending and
borrowing among relatives, friends, and neighbors. Borrowing from socially
close lenders is often the first recourse of poor households in financing
expenses, especially essential consumption expenditures. Transactions are
collateral-free and, as the IFPRI country studies show, interest is usually not
charged.26 These are essentially informal social insurance schemes
that have the principle of reciprocity at the core of the transactions.27
Hence, both the lender and the borrower gain from the transaction, and the
process is self-sustaining. The borrower is able to finance urgently needed
expenditures quickly and with few transaction costs; there is no lengthy
appraisal process, little or no paper work or travel time, and the terms of
transactions are easy to understand. The lender gains a right to reciprocity
that he can lay claim to in the future. Further, risk of a loan not being
recovered is minimal because the lender only lends to persons who are part of
his or her social network, within which contracts can be enforced. For each
partner, therefore, the long-term gains associated with maintaining borrowing
privileges is greater than the short-term gain from reneging on the payback.

· Rotating savings and credit
associations (ROSCAs), found in many countries, are also network-based but
address different needs of their members. The rules of conduct are more
formalized. These associations, which may even operate under a designated
manager, pool savings from members each period, and rotate the resulting pot
among them, according to various rules including random drawing. The process is
repeated each period until the last member receives the pot. Unlike demand
deposits, once the saving is committed, it usually cannot be withdrawn before
the members scheduled turn, although some groups do allow for an early
draw of the pot in an emergency situation.

· Informal moneylenders.
Typically, informal moneylenders are approached when the amount of credit
required is larger or is needed quicker than can be obtained from friends and
neighbors. Moneylenders lend for profit and often charge high interest rates.
Rates in the range of 5 to 7 percent per month are not uncommon.28
Typically, moneylenders lend only to households about whom they possess adequate
information. However, they may make an exception if punitive actions against
defaulters are feasible - if there is physical collateral that can be seized or
social collateral in the form of community pressure that can be exerted when
contracts are breached. The informal nature of these transactions must be
emphasized: more often than not, these sanctions are not enforced by any legal
authority but by the commonly understood rules of the communities themselves.

· Tied credit. Credit
transactions are frequently tied to transactions in land and labor markets to
circumvent problems of inadequate information and lack of assets suitable for
collateral. Traders, for example, disburse credit to farmers in exchange for the
right to market the growing crop; shopkeepers increase sales by providing credit
for food, farm inputs, and household necessities; large landholders secure
access to labor in the peak season in return for earlier loan advances to
laborers. In these types of transactions, the lender also deals with the
borrower in a nonlending capacity and is able to use this relationship to screen
applicants and enforce contracts. The grain buyer or the local sugar mill that
advances credit to the farmer, for example, is reasonably assured of repayment
because the loan can simply be deducted from future sales of the farmers
harvest.

·Household savings,
until recently, were perhaps the most overlooked component of rural finance.
Savings provide for the accumulation of capital, which, in turn, can generate
future income and enable future consumption. However, there is now ample
evidence that poor rural farmers save to build a precautionary buffer to be used
during lean seasons or to finance unexpected expenditures.29 For
example, in Cameroon, 59 percent of households reported saving for health care
or to meet family obligations, roughly 30 percent for education and house
construction, and less than 10 percent for agricultural
production.30

In general, the ingenuity of informal lenders and self-help
organizations in tailoring savings, loan, and insurance products to the
requirements of their clients or members makes them indispensable in both the
urban and rural financial landscape of developing countries.

Informal Systems Face Disadvantages as Well

Innovative and useful as the informal sector may be, it also
frequently runs up against severe constraints.31 Informal credit
markets, by their very nature, are segmented. A market typically
consists of a single village community or a socioeconomic group within a
village. And informal lenders seldom manage savings deposits. Hence, financial
intermediation in the sense of providing a common clearinghouse for borrowers
and lenders does not take place to the fullest extent possible. As a result, the
supply of credit is limited, resulting in either severe credit rationing or
extremely high interest rates for some borrowers.

It is not surprising, therefore, that in all the studies
conducted by IFPRI, informal sector transactions were small, short-term loans
taken in order to purchase urgently needed goods for household
consumption-especially food-or, to a lesser extent, inputs such as seeds and
fertilizer. The IFPRI study in Bangladesh, for example, found that in 1994 the
average size of a loan in the informal sector was about US$15 taken for about
three months. Invariably, when larger projects need to be financed, such as a
new enterprise, an irrigation pump, or the lease or purchase of agricultural
land, people often turn to formal lenders. Also, especially in agricultural
regions, droughts or floods affect both informal lenders and borrowers
simultaneously, so a credit supply crunch is likely to take place just when the
demand for credit peaks. Formal institutions such as banks usually have a
network of branches across different regions of a country and are therefore in a
better position to diversify risks. And when they are allowed to collect savings
deposits, they serve the needs of savers as well as borrowers. Formal
institutions can also leverage funds in other financial markets such as the bond
market.

Lessons from Informal Systems

A number of lessons can be derived from the workings of the
informal system:

· Credible
long-term partnership. That the accumulated benefits associated with
continued long-term transactions are larger than the short-term gains associated
with delinquent behavior is what makes informal loan contracts enforceable.
Formal institutions, similarly, must successfully demonstrate to clients that
they expect to be in business for a long time. This demonstration of stability
is essential for maintaining high repayment rates. Clients are usually astute in
making inferences about the permanence of new projects. Short-term and
sporadically implemented credit projects generally encounter higher rates of
loan delinquency precisely because the short-run gains from defaulting outweigh
uncertain future gains.

· Tailoring financial
services to specific demand patterns. As with the marketing of any product,
financial services must be sculpted to fit the specific demands of the borrowers
or savers. For the poor, the privilege of borrowing from various informal
institutions is worth preserving precisely because their services are responsive
to the households needs. Emergency loans, for example, can be obtained
immediately on demand; the repayment structure is closely linked to local
production cycles associated with the borrowers occupation; and loans can
be renegotiated, taking into account both the lenders and the
borrowers specific circumstances. These attributes greatly increase the
value of loans to borrowers and provide further incentive for them to retain
borrowing privileges.

On the other hand, when terms of loans are incompatible with
local production patterns or when loans are tied to activities that, given the
structure of local resources, yield poor returns, little is gained by retaining
borrowing privileges. Benefits from defaulting may outweigh the retention of
borrowing privileges. For example, agricultural credit programs frequently
provide credit for specific farm enterprises, usually export crops or main food
staples. The loan, most often for seeds and fertilizer, is frequently provided
in-kind, and the amount loaned is closely tied to the area devoted to the crop.
Thus, improving the credit line or using the loan to finance other remunerative
activities is not possible. This reduces the flexibility of the farm household
in making the best use of the loan. Under these conditions, the farmer may be
better off defaulting and investing the loan amount elsewhere.

· Knowledge of the local
economy is important; therefore, decisionmaking should also be made at the local
level. The ways in which informal agents successfully interlink financial
transactions with transactions in the markets for land, produce, and labor
provides yet another example of how financial products can be tailored to
clients requirements. To do this requires intimate knowledge of the
structure of the local economy as well as knowledge of existing institutional
arrangements that can potentially be used to strengthen contract enforcement.
Generally this is not possible within a top-down organizational framework.
Frontline managers must be actively involved in adapting financial products to
local institutional arrangements.

· Most financial contracts
are not self-enforcing, and adequate steps must be taken to enforce contract
compliance. Whereas the majority of informal financial contracts between
friends and relatives are self-enforcing, socially distant lenders depend on
explicit (though not necessarily legally codified) mechanisms to enforce
repayment. Just as moneylenders must obtain a mandate from small communities to
take punitive actions against defaulters, it is also important for formal
institutions to have clear, implementable, and well understood plans for
contract enforcement and loan recovery before lending begins. Lack of a credible
plan only invites default.

· Group-based transactions
hold promise. The existence of ROSCAS and networks of friends and relatives
indicate the possibility of using groups in formal lending and saving
activities. If groups can be made responsible for some of the screening,
monitoring, and enforcement functions, the risks would be reduced for formal
outsider institutions. Furthermore, group loans would be larger in
size and less costly to administer. Although the group-based concept has been
widely applied in formal rural financial systems in Asia, Africa, and Latin
America, little is known about the efficiency and outreach of groups, compared
with other member-based institutions such as credit unions or village banks.
Future research in this area is urgently needed.

· Provision of savings
services. The poor place a high value on savings services, especially when
the options provided combine security of deposit, value retention, and
flexibility in making savings deposits and withdrawals. For the banks, rural
savings mobilization can provide relatively inexpensive funds for on-lending.
The particular form in which household savings are kept is influenced by return,
liquidity, and risk. When investigating the savings behavior of the
food-insecure and poor, the standard definition of household savings and
investment, which focuses on money and physical assets, is too
narrow.32 It neglects the potential for savings to increase human
capital through investment in education and improved nutritional and health
status of family members. Such expenditures may not only increase the ability of
people to earn a living now, but they are likely to have a beneficial effect
well into the future.

· A question of
incentives. Borrowers and lenders in the informal market directly interact
with each other. This is not necessarily so in formal systems, where loan
managers may not have the same incentive to make good loans as owners or
trustees of the bank might have. For example, in most government-run
institutions, loan managers are not rewarded for making good loans. Therefore,
they are less likely to take sufficient care in screening clients or in taking
steps to recover loans swiftly. Formal lending systems should therefore
establish incentives that build on the loan managers knowledge of clients
in order to minimize fraud and other problems of contract
compliance.

Public Policy: Supporting Institutional Innovation

To reach the majority of the poor, institutional innovations are
needed that enable services to be expanded, while substantially reducing the
transaction costs for both the financial institutions and the clients. Long-term
support of institutional innovations in the rural financial sector may be the
most promising direction for public policy to take. Both governments and donors
must encourage institutional innovation and development, not micromanage banks
and other organizations, or initiate short-term projects that have no bearing on
institution building.

The Institutional Framework

In general, transaction costs can be brought down by improving
infrastructure such as roads, schools, and communications; by titling property
so that it can serve as collateral; or by improving institutions.33
While infrastructure development and land titling may prove politically or
economically feasible only in the long run, institutional innovations can be
fostered through public action, through the concerted efforts of donors,
governments, nongovernmental organizations, communities, and households.

Successful outreach requires institutional innovations that
reduce the risks and costs associated with lending and depositing small amounts
of money. Many of the transaction costs arise from the need to acquire
information about the market partner. Obtaining such information for small loans
can be prohibitively costly if the bank agent is asked to do this. Traditional
banking techniques, such as judging the loan application based on written
information, are either not feasible because of illiteracy or too costly to
administer. Yet, information about the creditworthiness of a loan applicant is
readily available within the local community through neighbors and other
peers.34 Such information can be obtained at less cost if networks or
institutions are based at the community level.

While there are several different forms that institutional
innovations in rural finance can take, all of the innovations build on locally
available information and exploit the cost advantage of informal monitoring and
enforcement systems. Within such systems, the functions of information
acquisition and monitoring and enforcement of financial contracts are largely
transferred from the bank to a group of borrowers and savers. The group members
share a common interest in gaining access to credit and savings services, and
they also possess enough low-cost information to adequately screen each other
and apply sanctions to those who do not comply with the rules. The major
difference between traditional and innovative banking for the poor is that in
traditional banking, the agent of a rural bank branch directly negotiates
savings or loan contracts between the retail banking institution and the
individual. In innovative approaches, on the other hand, a local institution
mediates between the bank and the individual and assumes many of the screening,
monitoring, and enforcement functions that are too difficult or too costly to be
executed by a bank agent.

Yet, differences in culture and socioeconomic systems do not
allow for institutional blueprints. While the principle of harnessing locally
available information and sanctioning and enforcement mechanisms is central to
institutional innovations in rural finance, the practical challenge lies in
finding how best to build and adapt these local community- and member-based
institutions and to link them with other institutions in the formal banking
system. So far, most institutional innovations in microfinance have been
generated by NGOs that do not have commercial profit as their principal
objective. By taking fresh approaches, these new microfinance institutions have
penetrated rural financial markets and serviced an underclass of borrowers in a
way that was unimaginable some 20 years ago.

In 1988, IFPRI published one of the most detailed studies then
available of the innovations in group-based banking introduced by the Grameen
Bank of Bangladesh, which has provided credit to 2.1 million women in 36,000
villages. Since then, IFPRI has examined the experiences of other institutions,
including member-owned village banks in Madagascar; other large-scale,
group-based credit programs in Bangladesh and Malawi; and savings and credit
cooperatives in Cameroon. Table 3 outlines some of the more important features
of these institutions. Some key common characteristics have been instrumental to
the success of most of these programs, and lessons for new program designs can
be derived from them:35

· Savings
arrangements are a prominent part of sustainable financial programs for the
poor. All of the innovative rural finance institutions in Table 3 have some type
of savings scheme. Savings schemes must take into account that clients,
especially the poorer ones, are motivated to save, among other reasons, as a
precaution against future risks. Therefore, it is important that products be
differentiated with respect to maturity, liquidity, and return to reflect this
concern.

· Group approaches have
shown clear potential for reaching poorer participants of financial markets, who
either do not possess suitable collateral or who cannot provide such collateral
at reasonable transaction costs for the lender. Most schemes make members
jointly liable for the repayment of loans and give subsequent credit only if the
group has fully repaid. The threat of losing access to future credit exerts
pressure on members to perform various tasks, including screening of loan
applicants, monitoring the individual borrowers, and enforcing repayment of
their peers loans.

· Demand-oriented financial
services are essential for wide outreach. The scope of lending services
offered to rural households must address not only production- and
income-generating activities but also consumption needs such as health,
education, and social obligations. Rural financial institutions should also be
able to put in place innovative refinancing and repayment procedures that are
flexible enough to accommodate unanticipated events affecting a household. This
may require unbureaucratic access to emergency loans or the buildup of emergency
funds by member-based financial institutions, which could possibly be pooled
through a regional or national second-tier institution.

Table 3 - Structure of innovative rural financial
institutions for the poor: Some examples from Africa and Asia

Institution

Percent of female members

Minimum balance/membership fee

Type of collateral requirement

Subsidization

Covering administrative costs

Percent of loan recovery

Length of operation

Growth (number of members)

(years)

Nonbank rural financial institutions

Bangladesh Rural Advancement Committee (BRAC)

80

Membership in a group. Regular savings requirement

Group liability, fraction of loan must be deposited as savings

Yes, but moderate. Many donors

Yes

95 to 100, over the years

26

121,000707,000 (1992)Over 1 million (1998)

Association for Social Advancement (ASA), Bangladesh

96 (1997)

Same as BRAC

Same as BRAC

Yes, in new donor-supported branches

Yes

99.9 (1997)

20

800,000 (1997)

Cooperative Credit Union League (CamCCUL), Cameroon

25

One membership share mandatory

Savings deposit with leverage 1:5, peer pressure

Yes, technical assistance

Yes

74 (1991)

20

50,000 (1983)72,000 (1989)

Mutual Assistance Credit Groups (MCAGs), China

Household is member

Admission fee ($2 to $20) or equivalent in grain

Savings with leverage 1:4, social capital as collateral
substitute

Yes, state and relief funds

Covered mostly by members

n.a.

Since 1992

About 170,000 MCAGs nationwide (1995)

Rural Credit Cooperatives (RCC), China

n.a.

Must buy shares

Savings, social capital as collateral substitute

Yes, state funds

Covered mostly by members

85 (1994)

Since late 1950s. Separated from Agricultural Development Bank
in 1994

RCC located in 96 percent of counties

Mutual credit and savings groups (CECAM), Madagascar

About 10

Yes, 1-5 times the daily wage (decided by members themselves)

Savings deposits with leverage 1:10/social capital

Yes, by international donors

Covered mostly by members

Above 90

8

Started 1990. 7,200 members in 90 villages (1997)

Member-Managed Village Banks (AECA) in Madagascar (also in
Cameroon, Mali, The Gambia)

About 30

Yes, decided by members

Member/village solidarity. Various loan sizes in relation to
savings deposit applied (varies with village bank)

Yes, technical assistance (by French NGO)

Covered by members

Close to 100

7

Started 1991. 1,830 members in 38 village banks (1997)

Village Development Funds, Segou, Mali

n.a.

No

Village savings fund for lending, leverage 1:10

Establishment assistance by BNDA

n.a., but financial success

100 (1988)

Start 1984

85 villages (1988)

Malawi Mudzi Fund (MMF)/Rural Finance Company (MRFC), Malawi

n.a.

No, but opportunity costs of time for group training/formation

Savings with leverage ratio 1:10. Social capital as collateral
substitute

Reorganized since 1984, 16.2 million depositors and 2.5 million
borrowers in 3,512 units

Note: n.a. means not
available

Conclusions

New innovative microfinance institutions have shown the
potential to reach people who live below the poverty line. But many of the
poorest of the poor remain excluded. To include this group, institutions must
market financial products suitable to the poorest group and reduce other entry
barriers faced by the poor.

IFPRIs impact assessment studies have mostly focused on
the short-run effects of credit access on income, food consumption, and
nutrition, which are positive for income, agricultural technology adoption, and
level of food expenditure and calorie intake. However, because the poor face so
many constraints, in some situations, investment in education, extension
services, health care, and improvements in infrastructure may be more
cost-effective ways of reducing poverty than provision of financial services.
But, in other situations, financial services may have to be combined with other
services and community action to make them effective.

Few impact assessment studies to date have attempted to compare
the social benefits at the village, household, and individual levels with the
social costs of supporting expansion of microfinance institutions.36
Research that compares the overall long-term effects of improved credit access
with program costs is urgently needed.

Despite their success, it would be unwise to conclude that the
new format of the micro-finance institutions such as the Grameen Bank can simply
be replicated elsewhere. One lesson is becoming increasingly clear: there is no
single blueprint for success. Recent experience indicates that programs should
be designed to harness a communitys particular strengths - its local
resources, agroecological characteristics, historical and cultural experiences,
and occupational patterns - in order to reduce costs of screening participants,
monitoring financial activity, and enforcing contractual obligations.
Institutional design may vary even for similar target groups within the same
country. In Bangladesh, for example, the Association for Social Advancement and
BRAC provide loans to clients themselves, while Rangpur-Dinajpur Rural Services
forms and trains groups, which then obtain agricultural loans from banks.

Designing, experimenting with, and building financial
institutions for the poor require economic resources and adequate consideration
of longer term social returns. Whether an institutional arrangement that is
suited to local conditions will also be accepted by the banking sector cannot be
known until it is tried. Since the market, by itself, has not been able to
stimulate much research and experimentation, public support in the institutional
experimentation and development phase is critical. Once viable prototypes are
identified, they will eventually be adopted by the private sector.

In the last two decades, NGOs have taken the lead in developing
innovative financial institutions partly because the subsidies they receive from
donors and government organizations make it feasible for them to allocate
resources to innovations. In their infant stage, cooperatives, village banks, or
groups are dependent on technical as well as financial assistance. For example,
technical assistance is needed to train members to read and maintain savings and
loan records; training is also needed to establish management and control
functions of newly formed groups. Financial assistance, on the other hand,
supplements initial savings deposits from clients to provide start-up capital
for lending. Only when these new institutions prove their creditworthiness over
a series of loan cycles are they likely to be accepted by commercial banks as
viable partners. In fact, banking laws may be required to accommodate, regulate,
and supervise new member-based financial institutions. Indonesia, for example,
has undergone a number of proactive regulatory changes in the financial sector
that have allowed member-based financial institutions to provide savings and
credit services to smallholders and microentrepreneurs.37

In a broader sense, just as public policy should play a role in
promoting technological innovations that generate social benefits, it should
also help promote institutional innovations that assist the disadvantaged or
address intrinsic market failures. As policymakers seek to make rational policy
choices, they must weigh the social costs of designing and building financial
institutions for the poor against their social benefits. Well-directed support,
including subsidies, to promising microfinance institutions is likely to have
payoffs in both services to the poor and reduced cost of services in the long
run. This is a point of view that those who argue for a complete removal of
subsidies should not ignore. Of course, some experiments in institutional
innovations will succeed, while many others will fail. Public policy will need
to support and evaluate this experimentation process and nurture those designs
or institutions that hold promise of future success. Governments, donors,
practitioners, and research institutions must work together closely to pinpoint
the costs, benefits, and future potential of emerging financial institutions.

In the long run, the payoff to public investment in
institutional innovations will lie in the transformation of now nascent
microfinance institutions into efficient and full-fledged financial
intermediaries that offer savings and credit services to smallholders, tenant
farmers, and rural entrepreneurs, thus alleviating poverty. Evidence of this
transformation is already emerging in countries such as Bangladesh, Indonesia,
and Thailand. The payoff will also come from the development of viable lending
methodologies that private commercial banks can readily adopt to profitably
provide savings and loan services to the poor. Like the development of new
high-yielding crop varieties in agriculture, institutional innovation generates
public goods that can be readily used by those who did not contribute to the
cost of development. The rapid growth in credit groups within and outside of
Bangladesh that replicate Grameen Bank principles is one example. Still another
example is found in Latin America where private commercial banks have started to
adopt group-based lending methods developed and tested by nonprofit
organizations that initially depended on public support. Another example is in
Kenya where the microfinance institution K-REP is now seeking permission to
operate as a bank.

In the final analysis, judging whether such institutional
innovations - generated by public action and through domestic or foreign
resources - pay off requires a critical look at the benefits that improved
access to financial services bring to the poor. It is therefore both welcome and
necessary that recent research has increasingly examined the impact of credit
programs on income and employment generation, food security and nutrition, and
poverty alleviation. With the right combination of public policy, private
initiative, and objective research, public investments in financial institutions
designed to serve the poor in rural areas of Africa, Asia, and Latin America are
likely to bear fruit as
well.

Notes

1.

In all countries, with the exception of China, Pakistan, and
Egypt, the household samples were chosen from areas where formal financial
institutions were operating. Hence, they are not representative of areas that do
not benefit from such services. However, they do provide a useful picture of the
characteristics of the poorest compared with the nonpoor in the selected areas.
A summary of study countries and related data sets is provided in M. Zeller, et
al., Research Proposal for IFPRIs Multicountry Project (MP5) on
Rural Finance Policies for Food Security for the Poor (International Food
Policy Research Institute (IFPRI), Washington, D.C., 1994). An earlier
cross-country synthesis for up to seven case study countries is contained in M.
Zeller, et al., Financial Services for the Rural Poor: A Multicountry
Synthesis and Implications for Policy and Future Research, a final report
to the German Ministry for Economic Cooperation and Development (BMZ) (IFPRI,
Washington, D.C., December 1996, photocopy). Detailed information on sampling
and results is available in the final reports for the following case studies.
For Bangladesh, see M. Zeller, M. Sharma, and A. U. Ahmed, Credit for the
Rural Poor: Country Case Bangladesh, a final report submitted to the
German Agency for Technical Cooperation (GTZ) (IFPRI, Washington, D.C., 1996,
photocopy). For Cameroon, see G. Schrieder and F. Heidhues, Credit
Policies for Food Security in Sub-Saharan Africa: The Case of Cameroon, a
final report submitted to GTZ (IFPRI, Washington, D.C., 1993); G. Schrieder,
The Role of Rural Finance for Food Security of the Poor in Cameroon
(Frankfurt, Germany: Lang Verlag, 1995). For China, see L. Zhu, Y. Jiang Zhong,
and J. von Braun, Credit for the Rural Poor in China, a final report
to GTZ (IFPRI, Washington, D.C., 1996, photocopy); and L. Zhu, Y. Jiang Zhong,
and J. von Braun, Credit Systems for the Rural Poor in China (New York:
Nova Science Publisher, 1997). For Egypt, see M. Sharma and M. Zeller, An
Analysis of Household Level Credit Transaction in Egypt, a report prepared
for the U.S. Agency for International Development (USAID) (IFPRI, Washington,
D.C., March 1998). For Ghana, see E. Kennedy, E. Payongayong, L. Haddad, T.
Tshibaka, R. Agble, and R. Tetebo, Impact of Credit Programs on Food
Security and Nutrition in Ghana, a report to USAID (IFPRI, Washington,
D.C., 1994, photocopy). For Madagascar, see M. Zeller, Credit Policies for
Food Security in Sub-Saharan Africa: The Case of Madagascar, a final
report to GTZ (IFPRI, Washington, D.C., 1993). For Malawi, see A. Diagne, M.
Zeller, and C. Mataya, Rural Financial Markets and Household Food
Security: Impacts of Access to Credit on the Socioeconomic Situation of Rural
Households in Malawi, a final report submitted to the Ministry for Women,
Children Affairs, Community Development, and Social Welfare, Malawi (IFPRI and
the University of Malawi, Washington, D.C., 1996). For Nepal, see M. Sharma,
Rural Credit Institutions and Subsistence Consumption: An Empirical Study
Based on Household Data from Nepal (Ph.D. diss., Cornell University,
Ithaca, N.Y., 1998). For Pakistan, see S. J. Malik, Credit Use, Poverty,
and the Role of Institutional Rural Credit: The Case of Pakistan (IFPRI,
Washington, D.C., 1994, photocopy).

2.

International Food Policy Research Institute, A 2020 Vision
for Food, Agriculture, and the Environment: The Vision, Challenge, and
Recommended Action (Washington, D.C.: IFPRI, 1995).

3.

Sharma, Rural Credit Institutions and Subsistence
Consumption: Nepal; Zeller, Credit Policies for Food Security in
Sub-Saharan Africa: The Case of Madagascar; Malik, Credit Use,
Poverty, and the Role of Institutional Rural Credit: The Case of Pakistan.

4.

The household sample in Ghana was drawn from villages with
credit programs that targeted relatively large loans to poor women. The survey
sampled many of these program beneficiaries, and the results reported in the
figure are the simple, nonweighted sample means. All data from other case
countries are weighted averages, thus correcting for oversampling of program
beneficiaries in the survey villages.

D. Adams and D. Fitchett, eds., Informal Finance in
Low-Income Countries (Boulder, Colo., USA: Westview Press, 1992). The
Consultative Group to Assist the Poorest (CGAP) estimates that fewer than 10
million of the few hundred million small businesses in urban and rural areas
have access to financial services. See Consultative Group to Assist the Poorest,
CGAP: A Micro-Finance Program, Focus Note No. 1 (World Bank: Washington,
D.C., 1996). The picture for rural and particularly agricultural entrepreneurs
is likely to be worse than for those operating in urban areas, however, because
banking services are mostly offered in urban and semiurban locations.

10.

See A. Diagne, M. Zeller, and M. Sharma, Determinants of
Household Access to and Participation in Formal and Informal Credit Markets in
Malawi and Bangladesh, a paper presented at the Annual Meeting of the
American Economics Association, Chicago, Illinois, January 3-5, 1998.

11.

M. Zeller, Determinants of Credit Rationing: A Study of
Informal Lenders and Formal Groups in Madagascar, World Development
22, no. 12 (1994): 1895-1907.

Joseph Stiglitz identifies 10 market failures in financial
markets, most of them related to imperfect and costly information, and develops
a set of principles for government intervention to respond to these market
failures. J. E. Stiglitz, The Role of the State in Financial Markets,
Working Paper No. 56 (Washington, D.C.: Institute for Policy Reform, 1992).

15.

BancoSol in Bolivia and the village banks of Bankya Rakyat
Indonesia (BRI) are examples of successful banking institutions that provide
savings and credit services on a sustainable, even profitable, basis to
low-income clientele. On the profitability of BRI, see J. Yaron and B. McDonald,
Recent Developments in Rural Finance, a paper presented at the
23rd Conference of the International Association of Agricultural
Economists, Sacramento, California, U.S.A. August 1997.

The methodologies used in the impact evaluation in IFPRIs
country studies are described in Zeller et al., Financial Services for the
Rural Poor. To account for potential selection bias, all IFPRI country
studies use a two-stage econometric estimation procedure. The first stage
measures the influence of factors that affect either access to or participation
in the formal and informal credit market. The second stage then estimates the
effects of predicted credit access or program participation on various outcome
variables.

On this argument, see, for example, Zeller et al.,
Research Proposal for IFPRIs Multi-Country Research Project on Rural
Financial Services; D. Van de Walle, Comments on Rural Finance
in Africa: Institutional Developments and Access for the Poor by Ernest
Aryeetey, in Annual World Bank Conference on Development Economics,
ed. M. Bruno and B. Pleskovic (Washington, D.C.: World Bank, 1996).

25.

Adams and Fitchett, eds., Informal Finance in Low-income
Countries.

26.

See M. Zeller, S. Broca, and M. Sharma, Financial Services
for the Rural Poor: A Multicountry Synthesis and Implications for Policy and
Future Research, final report to the German Agency for Technical
Cooperation (GTZ) (International Food Policy Research Institute, Washington,
D.C., December, 1996, photocopy)

This section draws from M. Zeller and M. Sharma, Rural
Financial Services for Poverty Alleviation: The Role of Public Policy,
1996 Report (Washington, D.C.: International Food Policy Research
Institute, 1997).

For discussions on actions by group members in cases of
individual loan defaults, for Costa Rica, see M. D. Wenner, Group Credit:
A Means to Improve Information Transfer and Loan Repayment Performance,
Journal of Development Studies 32, no. 2 (1995): 263-81; and for
Madagascar, M. Zeller, Determinants of Repayment Performance in Credit
Groups: The Role of Program Design, Intragroup Risk Pooling, and Social
Cohesion, Economic Development and Cultural Change (1998): 599-620.

35.

Zeller et al., Rural Finance for Food Security for the
Poor.

36.

One in-depth study is supported by the World Bank and the
Bangladesh Institute for Development Studies; see, for example, S. R. Khandker,
Grameen Bank: Impact, Costs, and Program Sustainability, Asian
Development Review 14, no. 1 (1996): 97-130.